Martin Lipton, who knows a thing or two about corporations, presents:
On June 25, I presented a paper entitled “Shareholder Activism and the “Eclipse of the Public Corporation”: Is the Current Wave of Activism Causing Another Tectonic Shift in the American Corporate World?” at the 2008 Directors Forum of The University of Minnesota Law School. The paper discusses the pressures that have been pervasively eroding the centrality of the board of directors and transforming its role in the governance structure of public companies, with the end game being a new conception of the corporate organization. Against the backdrop of the subprime and leveraged loan financial crisis and other recent events, the paper addresses what I regard as the crux of the issue affecting public companies today: whether the institution of the corporate board can cope with these pressures and survive as the vital governing organ of public companies. Or, will a forced migration from director-centric governance to shareholder-centric governance, along with a concomitant transformation of the role of the board from guiding and advising management to ensuring compliance and performing due diligence, simply overwhelm American business corporations?
I say the latter, and that’s why so many companies have gone private lately. The paper is available here. For reference, he notes what he thought a year and a half ago:
That is, while the public corporation would continue, it would be eclipsed by a new corporate form: the privately owned corporation that uses public and private debt, rather than public equity, as the major source of capital. Since the time I gave that speech, however, the subprime and leveraged loan financial crisis has significantly altered the corporate landscape.
The paper’s worth a read, not least to see what one of the most-informed corporate thinkers has on his mind. Here’s part of the conclusion:
At its core, the board-centric model of governance is premised on the notion that boards merit the vote of confidence of shareholders and the public markets, …
That’s the same thing I was thinking as I read the paper. Here’s how he finishes that sentence:
and notwithstanding the strong current of distrust that runs through many corporate governance reforms, history has proven this vote of confidence to be well deserved.
He has one piece of particularly strong evidence: in general, public corporations have done very well, returning 8-12% annually. But the idea has always been a little crazy.
Think of your typical pension fund investor and just how far removed they are from the actual use of their money in a basic corporation with minimal management structure. The investor gives their money to the pension fund (1) which purchases a moderate amount of control over the selection of a board of directors (2) that monitors and reviews the work of executives (3) who command their subordinates (4) to manage employees (5) actually working to make a return. Odds are, the investor could get closer to the employees on the ground by playing six degrees of separation.
That system was bound to come apart at some time. I think the information revolution of the past 20 years has finally made it happen by enabling detailed accounting and review of these massive organizations; trust is no long essential, it’s merely good. Further, the Internet has increased the speed at which the market reacts, thus raising the stakes even further for investors, who now will only have a very small window in which to escape if internal misconduct becomes public. That’s important because the desire to flee is strongly contradicted by the evidence that waiting out the market can trash traditional buy-and-hold strategies (e.g., missing the best ten months between small company stocks between 1925 and 1992 slashed gains from 12% to 6%).
In this day and age, investors can easily feel their money is trapped by a large public corporation.
So what’s next? I think the information revolution will continue its course. Just as it is now possible to quickly do a wholesale accounting and review of a massive international corporation, it is also possible — or at least soon will be possible — for investors to keep close tabs on private corporations, even without the benefits of the openness and the economies of scale that come with public trading.
I thus foresee over the next few years growth in mid-size and large private corporations where the investors have extensive access to the records in real-time; perhaps not the same level as in a small private company, but far more than investors and public companies now have. We’ve already started to see that trend with the recent explosion of private equity groups like Blackstone.
What does it mean for lawyers? Well, it’s hard to dispute that securities class actions have become tightly regulated. The Private Securities Litigation Reform Act of 1996 shrank the market for securities class actions, narrowing the field of plaintiff and defense lawyers while also tightening those claims to the ones with the strongest pre-litigation proof. There is thus simply less demand for securities class action work.
The private equity boom will go in the opposite direction. The marketplace for private companies with a large number of investors is unsettled and barely regulated, which makes for lawsuits. Most likely, the less-savvy companies will be thrown together with generic LLC agreements that fail to address a number of issues (always fertile ground for lawsuits) while the more-savvy ones will send everything to arbitration, where such disputes probably should be anyway. The truly savvy investors will submit to arbitration (to get faster results on valid claims), but will extract heavy concessions for it, like clauses permitting them extensive records review.
So who will fill that demand? Will securities class action attorneys start looking towards pushing fraud and similar claims through arbitration, or will commercial litigators move from ordinary inter-company breach of contract to intra-company shareholder and ownership disputes? Since few investors will be prepared to start shelling out serious funds it would require to prosecute these actions, I bet the former will probably have more of an impact than the latter, given how they are better suited structurally and temperamentally for plaintiff’s work on a contingency basis.